istonormalizethembyaveragingtheexpensesacrosstime
and reducing this year’s income by this amount.
4.Itemsthatrecureveryyearthatchangesigns—positivein
someyearsandnegativeinothers.Consider,forinstance,the
effectofforeigncurrencytranslationsonincome.Forafirm
intheUnitedStates,theeffectmaybe negativeinyearsin
whichthedollargetsstrongerandpositiveinyearsinwhich
thedollargets weaker.Themost prudentthingto dowith
these expenses would be to ignore them. This is because
income gains orlossesfrom exchange ratemovements are
likelytoreversethemselvesovertime,andmakingthempart
of permanent income can yield misleading estimates of value.
To differentiate among these items requires that we have
accesstoafirm’sfinancialhistory.Foryoungfirms,thismay
not be available,making itmoredifficultto drawthe line
between expenses that should be ignored, expenses that
shouldbenormalized,andexpensesthatshouldbeconsidered
in full.
Adjusting for Acquisitions and Divestitures
Acquisitionaccountingcanwreakhavoconreportedearnings
foryearsafteranacquisition.Themostcommonbyproductof
acquisitions, if purchase accounting is used, is the
amortization of goodwill. This amortization can reduce
reportednetincomeinsubsequentperiods,thoughoperating
income should be unaffected. Should we consider
amortizationtobeanoperatingexpense?Wethinknot,since
itisbothanoncashandoftenanontax-deductiblecharge.The
safestroutetofollowwithgoodwillamortizationistolookat
earnings prior to the amortization.